European sovereign euro-zone debt crisisperiod of economic uncertainty in the euro zone beginning in 2009 that was triggered by high levels of public debt, particularly in the countries that were grouped under the acronym “PIIGS” (Portugal, Ireland, Italy, Greece, and Spain).

Prelude to the crisis

The debt crisis was preceded by—and, to some degree, precipitated by—the global financial downturn that soured economies throughout 2008–09. When the “housing bubble” burst in the United States in 2007, banks around the world found themselves awash in “toxic” debt. Many of the so-called subprime mortgages that had fueled the tremendous growth in U.S. home ownership were adjustable-rate mortgages that carried low “teaser” interest rates in the early years that swelled in later years to double-digit rates that the home buyers could no longer afford, leading to widespread default. Frequently, mortgage lenders had not merely held the loans but sold them to investment banks that bundled them with hundreds or thousands of other loans into “mortgage-backed” securities. In this way, these loans were propagated throughout the entire global financial system, causing overleveraged banks to fail and triggering a contraction of credit. With banks unwilling to lend, the housing market declined further as excess inventory from the bubble years combined with foreclosures to flood the market and drive down property values.

Around the world, central banks stepped in to shore up financial institutions that were deemed “too big to fail,” and they enacted measures that were designed to prevent another, larger banking crisis. Finance ministers of the G7 countries met numerous times in an attempt to coordinate their national efforts. These measures ranged from cutting interest rates and implementing quantitative easing—an attempt to increase liquidity through the purchase of government securities or bonds—to injecting capital directly into banks (the method used by the United States in the Troubled Asset Relief Program) and the partial or total nationalization of financial institutions.

The first country other than the United States to succumb to the financial crisis was Iceland. Iceland’s banking system completed privatization in 2003, and subsequently its banks had come to rely heavily on foreign investment. Notable among these institutions was Landsbankinn, which offered high-interest savings accounts to residents of the United Kingdom and the Netherlands through its Internet-based Icesave program. Iceland’s financial sector assets ultimately exceeded 1,000 percent of the country’s gross domestic product (GDP), and its external debt topped 500 percent of GDP. In October 2008 a run on Icesave triggered Landsbankinn’s collapse. When Iceland’s government announced that it would guarantee the funds of domestic account holders but not foreign ones, the news rippled through the financial systems of Iceland, the Netherlands, and the United Kingdom. Nearly 350,000 British and Dutch Icesave depositors lost some $5 billion, and the ensuing debate over who would compensate them caused a diplomatic rift between the three countries that would take years to heal.

Within weeks of Icesave’s failure, Iceland’s massively overleveraged banks had been virtually wiped out, its stock market had plummeted roughly 90 percent, and the country, unable to cover its external debts, was declared to be in a state of national bankruptcy. The Icelandic government collapsed in January 2009, and incoming prime minister Jóhanna Sigurðardóttir imposed a series of austerity measures to qualify for bailout loans from the International Monetary Fund (IMF). What separated Iceland from the debt crises to come, however, was its ability to devalue its currency. Iceland was not a member of the euro zone, and its currency, the krona, was allowed to depreciate dramatically against the euro. Inflation subsequently skyrocketed and GDP sharply contracted, but real wages began a slow recovery in 2009.

The crisis unfolds

Since the creation of the euro zone, many member countries had run afoul of the financial guidelines laid forth in the Maastricht Treaty, which had established the European Union (EU). These requirements included maintaining annual budget deficits that did not exceed 3 percent of GDP and ensuring that public debt did not exceed 60 percent of GDP. Greece, for example, joined the euro zone in 2001, but it consistently topped the budget deficit limit every year. However, the lack of any real punitive enforcement mechanism meant that countries had little incentive to abide by the Maastricht guidelines. Although each of the PIIGS countries arrived at their moments of crisis because of different factors—a burst housing bubble in Spain, a shattered domestic banking sector in Ireland, sluggish economic growth in Portugal and Italy, and ineffective tax collection in Greece were among them—all of them presented a threat to the survival of the euro.

The EU response to the crisis was spearheaded by German Chancellor Angela Merkel, French Pres. Nicolas Sarkozy, and European Central Bank (ECB) president Jean-Claude Trichet (succeeded by Mario Draghi in October 2011). Germany, as Europe’s largest economy, would shoulder much of the financial burden associated with an EU-funded bailout plan, and Merkel paid a domestic political price for her commitment to the preservation of the EU. Billions of dollars in loans from the EU and the IMF would ultimately be promised to ailing euro-zone economies, but their disbursement would hinge on the willingness of the recipients to implement a wide range of economic reforms.

Timeline of key events in the European sovereign debt crisisOctober 2009In a snap election called by Prime Minister Kostas Karamanlis of the New Democracy (ND) party, Greek voters express their dissatisfaction with a sluggish economy by emphatically supporting the opposition Panhellenic Socialist Movement (PASOK). PASOK leader George Papandreou is sworn in as prime minister.November 2009Papandreou’s administration uncovers evidence that misleading accounting practices had concealed excessive borrowing by the preceding NDP government. Based on corrected figures, the Greek budget deficit for the year more than doubles to 12.7 percent of GDP.December 2009Ratings agencies Fitch and Standard & Poor’s downgrade Greece’s credit rating to below investment-grade status. The Greek stock market tumbles, and the Papandreou administration reveals that Greece’s sovereign debt burden now tops €300 billion (about $440 billion). This puts Greek debt at 113 percent of GDP, almost double the amount allowed under Maastricht.Having spent billions to shore up its beleaguered banks, Ireland implements austerity measures that include increasing the minimum eligibility age for pensioners from 65 to 66.February 2010Papandreou unveils an austerity plan aimed at reducing Greece’s budget deficit by almost 10 percent by 2012. It includes a freeze on public-sector wages and a variety of tax increases. The EU endorses the plan, but protests and wildcat strikes sweep the country.Spanish Prime Minister José Luis Rodríguez Zapatero, facing an economy rocked by plunging property values and soaring unemployment, announces an austerity plan that would increase the retirement age from 65 to 67. Labour unions lead mass demonstrations against the change, but after almost a year of negotiations the plan is approved in January 2011.March 2010Papandreou proposes a new financial package for Greece that includes additional public-sector pay cuts and a 2 percent sales tax increase. He meets with German Chancellor Angela Merkel, French Pres. Nicolas Sarkozy, and U.S. Pres. Barack Obama but maintains that Greece is not in need of a bailout. By the end of the month, leaders of the euro zone and the IMF have agreed upon a deal whereby both parties would provide financial support for Greece.April 2010The 2009 Greek budget deficit is revised up to 13.6 percent, and Greek government bond yields skyrocket as Standard & Poor’s downgrades their credit worthiness to junk status. May 2010On May 2 Papandreou, the IMF, and euro-zone leaders agree to a €110 billion ($143 billion) bailout package that would take effect over the next three years. In response, some 50,000 people take to the streets of Athens to protest the additional budget cuts mandated under the terms of the deal. Three people are killed when the demonstrations turn violent.Responding to rising Portuguese bond yields and continued volatility in the value of the euro, the EU and the IMF create a €750 billion ($1 trillion) emergency fund to shore up flagging euro-zone economies.June 2010On June 8 the euro closes at $1.19, its lowest rate of exchange against the U.S. dollar since March 2006.July 2010The EU releases the results of “stress tests” conducted on 91 European financial institutions. Of the banks that were tested, seven did not maintain the minimum amount of ready capital required by examiners.September 2010Ireland’s central bank announces that the cost of bailing out Anglo Irish Bank, nationalized by the Irish government in January 2009, could reach as much as €34.3 billion ($46.6 billion). This pushes Ireland’s budget deficit to 32 percent of GDP.November 2010After months of delay, Ireland’s government officially applies for bailout funds from the EU and the IMF. Embattled Irish Prime Minister Brian Cowen submits a harsh austerity budget and promises to call a general election in 2011. Within a week an €85 billion ($113 billion) rescue package is approved by European leaders.February 2011European finance ministers create the European Stability Mechanism, a permanent €500 billion ($673 billion) fund intended to serve as a lender of last resort for ailing euro-zone economies.March 2011Portuguese Prime Minister José Sócrates resigns when opposition politicians reject his proposed austerity budget. Portuguese government bond yields rise to unsustainable levels as Fitch and Standard & Poor’s cut their ratings of Portuguese sovereign debt.April 2011Sócrates, serving in a caretaker role pending elections in Portugal, requests bailout relief from the EU and the IMF.May 2011European leaders approve a €78 billion ($110 billion) bailout package for Portugal on the condition that Portuguese officials implement a series of austerity measures.June 2011Standard & Poor’s downgrades Greece’s credit rating to CCC, making it the country with the world’s lowest-rated sovereign debt. A fresh round of budget cuts and austerity measures are greeted with widespread protests.July 2011Unimpressed with Portugal’s recovery in the wake of the May 2011 bailout package, Moody’s rating agency lowers the country’s debt rating to junk status.European leaders extend an additional €109 billion ($155 billion) rescue package to Greece. In an effort to stabilize the euro zone as a whole, existing Greek loans are restructured with more generous terms. The cost of these changes is passed along to private bondholders, and Fitch characterizes the action as a “selective default.” This marks the first government default within the euro zone since the adoption of the single currency.August 2011Interest rates on 10-year Italian government bonds top 6 percent as confidence in the coalition led by Italian Prime Minister Silvio Berlusconi is undermined by Berlusconi’s personal scandals and his ongoing row with finance minister Giulio Tremonti. Italy’s €1.9 trillion ($2.7 trillion) public debt falls under increasing scrutiny from investors; at 120 percent of GDP, Italy’s rate of indebtedness is second only to Greece among euro-zone countries. In an effort to calm the markets, Berslusconi proposes €45 billion ($66 billion) in spending cuts and tax increases.September 2011Switzerland, a non-EU country surrounded by euro-zone economies, has watched its currency, the franc, appreciate dramatically against the struggling euro. With export and tourism revenues falling, the Swiss National Bank stuns the international currency market by devaluing the franc and pegging its value to that of the euro.In anticipation of parliamentary action on Berlusconi’s proposed austerity measures, Italy’s largest labour union organizes a one-day general strike that virtually shuts down the country. Italy’s legislature ultimately approves a €54 billion ($74 billion) amended austerity package with the intention of wiping out Italy’s budget deficit by 2013. In spite of these measures, Standard & Poor’s downgrades Italy’s credit rating and characterizes the outlook for the euro zone’s third largest economy as negative.October 2011Slovakia’s coalition government collapses when Prime Minister Iveta Radičová ties her country’s approval of the expansion of the European Financial Stability Facility (EFSF), the EU’s primary bailout mechanism, to a confidence motion in parliament. Unanimous consent from the 17 members of the euro zone is required for the authorization of the more robust fund, the future of which is put in doubt by Slovakia’s no vote. Within days of the toppling of the Radičová government, however, the Slovak parliament reconsiders the matter, and the EFSF is approved.One day after Berlusconi narrowly survives a crucial confidence vote in Italy’s parliament, demonstrations turn violent in Rome, and more than 100 protesters are injured. The riots mar an otherwise peaceful day of global protest coordinated by such groups as the indignados (“angry ones”) in Spain and the Occupy Wall Street movement in the United States.Greek lawmakers narrowly approve another round of tax increases and public-sector wage cuts as a 48-hour general strike shuts down Athens and anti-austerity protests turn violent. Dozens are injured in clashes between demonstrators and police, and an estimated 50,000 protesters occupy the public square outside the Greek parliament building.Euro-zone leaders meet in Brussels for a summit that, it was hoped, would produce a lasting solution for the debt crisis. Merkel and Sarkozy negotiate privately with Greece’s creditors, and the result is a bond swap that would effectively cut the value of Greek debt in half. Additional bailout measures include the recapitalization of European banks and the expansion of the EFSF into a €1 trillion ($1.4 trillion) slush fund to insulate larger indebted economies such as Italy.Global financial markets are rocked as Papandreou calls for a referendum on the latest EU bailout plan. He promptly faces an internal revolt, as members of his own party call for him to resign, and the opposition demands early elections.November 2011A summit of G20 leaders convenes at Cannes, France, on November 3 to discuss the IMF and the ongoing euro-zone crisis. For the first time, European leaders publicly declare that Greece’s departure from the single currency is a possibility, with Sarkozy stating that “now it is up to [Greece] to decide” on the matter. Papandreou responds by abandoning the planned referendum.Italian bond yields continue to soar, and on November 8 Berlusconi effectively loses his parliamentary majority on a budget vote that is seen by many as an unofficial vote of confidence. Later that day he announces that he will resign as soon as parliament approves a new round of economic reforms. Investors are slow to respond to the news, however, and yields on Italian government 10-year bonds reach an unsustainable 7.5 percent.On November 9, after days of deliberation with opposition leaders, Papandreou announces his resignation. The following day a caretaker government is formed around former European Central Bank vice president Lucas Papademos, and he is sworn in as interim prime minister of Greece on November 11.Berlusconi’s budget passes, and he resigns on November 12. He is replaced by Mario Monti, a politically independent economist who previously served on the European Commission. Monti spends the following weeks assembling his government, and the markets respond negatively to the delay. In a bond auction held on November 29, 10-year yields top 7.5 percent, while 3-year bonds approach 8 percent.On November 20 Spain becomes the third euro-zone country in three weeks to see a change in government. Spanish voters sweep the ruling Spanish Socialist Workers’ Party (PSOE) from power, handing the Popular Party (PP) an overall majority in parliament. Zapatero remains caretaker prime minister while PP leader Mariano Rajoy begins the task of forming a new government.Standard & Poor’s downgrades Belgium’s credit rating, a decision that was based largely on the country’s record 530 days without a formal government. Belgian 10-year-bond yields jump to 5.86 percent, their highest rate in more than a decade. In a reversal of the overall trend, the euro-zone crisis triggers the creation of a government rather than the downfall of one, as the country’s lawmakers work with renewed urgency to build a coalition.December 2011Socialist Elio Di Rupo, one of the key negotiators during Belgium’s political deadlock, emerges as the favourite compromise candidate to lead a grand coalition government. Di Rupo is sworn in as prime minister on December 6, and he pledges to cut spending and reduce Belgium’s deficit. Belgian bond yields decline sharply but remain well above their 2010 levels.European leaders convene in Brussels on December 9 (exactly 20 years after the European Council meeting that concluded with the Maastricht Treaty) for a summit that promises to reshape the EU. Sweeping changes are proposed to integrate euro-zone economies more deeply, creating a “fiscal stability union,” and additional penalties are suggested for countries exceeding specific deficit benchmarks. The compact can be enacted by changing an existing EU treaty protocol, a process that will require unanimous approval from the 27 EU leaders present. Those plans are scuttled by British Prime Minister David Cameron, who withholds his vote when he is unable to secure regulatory exemptions for London’s financial sector. Cameron’s “veto” ultimately has little effect, as the other 26 members of the EU press ahead with the treaty changes; those changes will face referenda or parliamentary approval at the member country level.A war of words erupts between France and the United Kingdom in the wake of the December 9 summit, as markets react with ambivalence to the measures proposed there. Fitch lowers France’s economic outlook to “negative,” and Moody’s cuts Belgium’s credit rating. The euro continues its seven-month slide against the dollar, as analysts cite a lack of decisive action on the part of EU leaders and the European Central Bank for the loss of faith in the single currency. EU Pres. Herman Van Rompuy attempts to repair the breach with Cameron by extending “observer” status to the United Kingdom in the fiscal union negotiations.On December 21 the European Central Bank (ECB) extends €489 billion (nearly $640 billion) in loans to more than 500 European banks. The long-term refinancing operation is designed to prevent a credit freeze, and it represents the largest such deal in ECB history. The three-year loans are offered at a fixed 1 percent interest rate, and their widespread adoption indicates a radical shift in the mood of the private banking sector, which had long held capital injections from central banks to be anathema.January 2012Standard & Poor’s downgrades nine euro-zone countries, stripping France and Austria of their AAA ratings and classifying the debts of Portugal and Cyprus as junk. This makes Portugal the second European country (after Greece) to have its debt downgraded to non-investment status by all three ratings agencies. Portuguese 10-year-bond yields skyrocket in response to the news, eventually reaching a euro-era record 18.29 percent.European leaders meet in Brussels on January 30 to finalize the financial compact initially proposed in December 2011. The treaty will impose specific guidelines for fiscal discipline upon its signatories, and 25 of the 27 EU member states agree to its terms, with the United Kingdom and the Czech Republic opting out.February 2012As Greek lawmakers debate another round of austerity measures, violent street protests erupt in Athens. Dozens are injured as protesters clash with police, and several buildings are set ablaze. The Greek parliament ultimately approves the spending cuts, which opens the door to an additional €130 billion (about $173 billion) in bailout funds from the ECB, the EU, and the IMF. Global markets respond positively to the news, but initial gains are erased by the continued possibility of an uncontrolled Greek default.Moody’s cuts the debt ratings of six European countries, including Italy, Portugal, and Spain, and downgrades its economic outlook on France and the United Kingdom to negative. It affirms its top rating of the EFSF, however, a move that reassures investors in the wake of Standard & Poor’s downgrading of the fund the previous month.Some 800 European banks take advantage of the ECB’s second long-term refinancing operation. This round of loans injects an additional €530 billion (about $700 billion) into the banking system. In just over two months the ECB has loaned more than €1 trillion (about $1.3 trillion) to private banks in an effort to increase liquidity in the credit market and to encourage lending to what ECB chairman Mario Draghi calls the “real economy.”March 2012On March 2, 25 EU countries sign the new pact on fiscal discipline. While it will be binding only for those countries that use the euro, the other signatories can choose to abide by its guidelines. Unlike previous EU treaties, unanimous support from member countries is not required, and the agreement will enter into force upon ratification by 12 of the 17 euro-zone countries. Irish Prime Minister Enda Kenny announces that his country will hold a referendum on ratification. The United Kingdom and the Czech Republic, neither of which use the euro, opt out of the treaty entirely.Yields on Italian and Spanish 10-year bonds drop to 5 percent, but unemployment across the euro zone hits a record high. Unemployment rates in Spain and Greece hover around 20 percent, while rates for those under age 25 approach a staggering 50 percent. Manufacturing activity in the euro area continues to decline, and the EU reports that the euro area’s economy contracted 0.3 percent in the final quarter of 2011.With a majority of private bondholders agreeing to swap their existing Greek government bonds for ones with a longer term, a lower interest rate, and less than half the previous face value, on March 9 the Greek government exercises “collective action clauses” to force the remaining bondholders to accept the deal. The action allows Greece to erase some €100 billion (about $130 billion) in government debt. Unlike the “selective default” of July 2011, through which the participation of bondholders was voluntary, the activation of the collective action clauses marks the event as a true loan default. The International Swaps and Derivatives Association declares that a “credit event” has occurred, a decision that triggers the payout of billions of dollars in credit-default swap insurance.One day after a general strike drew hundreds of thousands of protesters to the streets in Barcelona and Madrid, the government of Spanish Prime Minister Mariano Rajoy unveils a budget that cuts some €27 billion (about $35 billion) in spending, a reduction of almost 10 percent from 2011 levels. The austerity measures are intended to bring Spain back into line with the new EU fiscal pact. Earlier in the month, Rajoy had announced that he was revising Spain’s 2012 public deficit goal from 4.4 percent to 5.8 percent of GDP. EU ministers responded harshly, and Rajoy was forced to compromise with a deficit target of 5.3 percent.Euro-zone finance ministers announce an expansion of the EFSF and European Stability Mechanism. The two primary elements of the euro zone’s financial firewall will now have access to a combined €800 billion (about $1 trillion) in funding. This increase was made at the urging of the G20 and the IMF, who had expressed concern that the existing rescue funds were not sufficient to manage the bailout of a country such as Spain or Italy.April 2012On April 4 a retired pharmacist commits suicide a short distance from Greece’s parliament as an act of protest against deepening pension cuts. He immediately becomes a symbol for groups opposing the austerity measures adopted by the Papademos government, and violent clashes between police and demonstrators erupt in Athens.After a Spanish government bond auction falls short of its fund-raising target, the Rajoy government attempts to reassure markets with an additional €10 billion (about $13 billion) in budget cuts. Yields on Spanish bonds continue to rise, however, and the 10-year benchmark rate once again tops 6 percent—the first time it has done so since Rajoy took office in December 2011.Dutch Prime Minister Mark Rutte proposes cuts to popular social welfare programs as part of an austerity budget intended to bring the Netherlands into compliance with the EU’s recently adopted deficit cap. Geert Wilders withdraws the support of the Freedom Party for the prime minister’s minority coalition, and the government collapses. Rutte remains in power as a caretaker while new elections are scheduled.May 2012Anti-austerity candidates sweep into office across Europe. Socialist candidate François Hollande is elected president of France, and he immediately changes the focus of the debt crisis debate from austerity to growth. The major parties in Greece are rejected in snap elections that strongly favour anti-austerity and ultranationalist candidates. With no party able to form a government, new elections are planned for June 2012. Communists, Greens, and a protest party led by comedian Beppe Grillo dominate in local elections in Italy as support collapses for the scandal-plagued Northern League, which had been instrumental in the long-term survival of the Berlusconi government.While market analysts begin to discuss a “Grexit” (“Greek exit” from the euro zone), capital flight becomes a growing concern as depositors fear a possible return to the drachma. Greek banks have shed almost one-third of their total deposits since 2010, and on May 14 alone Greek savers withdraw some €700 million (almost $900 million) from the Greek banking system.Bankia, Spain’s largest mortgage lender, is effectively nationalized. The Spanish government announces a €23.5 billion (more than $29 billion) bailout of the ailing bank, and Standard & Poor’s downgrades Bankia and two other Spanish financial institutions to junk status. In addition to the banking crisis, Spain faces regional governments that are struggling with unsustainable debt, and, for the fourth year in a row, it registers the highest overall unemployment rate in the EU. The return on Spanish 10-year bonds continues to hover around 6.5 percent. After the American ratings company Egan-Jones downgrades Spanish debt to junk status, the euro declines strongly against the yen and the pound, and it hits a 22-month low against the dollar.